FOMC Minutes Jitters Push Risk Lower

More of the same downward drift this overnight trading session, with early Asian outflows coupled with a fresh record low in the Indian currency, driven in part by reports the Fukushima leak severity had been raised from Level 1 to Level 3, which however subsequently reversed following a weakening in the JPY and pushed the Nikkei from a steep early drop to a modest green close. China was unchanged even as Fan Jianping, chief economist at the State Information Center, said that a new reasonable range for China’s growth is 7%-9%, Xinhua said and ongoing liquidity additions by the PBOC. In Europe, newsflow was dominated early on by a Suddeutsche report that the third Greek bailout would be likely financed in part by EU budget as the reality that nothing is fixed in Europe slowly returns and fears that the latent and non-existent OMT will eventually have to be used. US futures have seen a modest risk off bias in part driven by concerns what today's key event, the FOMC minutes due out at 2 pm, would reveal (if anything new). Also on deck are Existing home sales at 10:00 am which expect a slight pick up to 5.15 million from a 5.08 million prior print. Moments ago the latest weekly MBA Mortgage Applications number came out and, to nobody surprise, it posted the last weekly decline, dropping another 4.6% with conventional refis dropping for the 10th consecutive week.

Overnight headlines news bulletin from Bloomberg

Treasuries ease before Fed releases minutes of its July meeting at 2pm in Washington; will be closely scrutinized for signals on possible tapering of asset purchases.

Minutes likely to show discussion of logistical details without commitment to specific date or size/composition, Jefferies says

Tapering this year could be “highly disruptive” if new FOMC members want to pursue different policy in 2014, Bob Eisenbeis, chief monetary economist at Cumberland Advisors and former research director at Atlanta Fed wrote

Investors captivated by the Fed next move on bond purchases are ignoring the risk that Europe’s debt crisis will recur, according to Morgan Stanley

German Social Democratic leaders stepped up their attacks on Chancellor Merkel over the costs of the debt crisis, accusing her of trying to conceal the need for a third Greek aid program until after the election

Bundesbank president Jens Weidmann said he would welcome timely publication of ECB minutes, saying in an interview with a German magazine that “more transparency would definitely contribute to better public understanding of the decisions of the ECB”

A new reasonable range for China’s growth is 7%-9%, Xinhua said, citing Fan Jianping, chief economist at the State Information Center

Malaysia cut its forecast for growth this year after 2Q expansion missed economists’ estimates, adding pressure on policy makers to bolster confidence as the ringgit weakens

FOMC Minutes due at 1900BST/1300CDT - Markets looking for any signs or signals of discussions of tapering ahead of the September FOMC meeting.

Italy's Berlusconi said to have given Italian PM Letta and his allies ten days to find a solution that will allow him to remain in politics or withdraw from the coalition if Senate votes Berlusconi out of Parliament.

Greece's 3rd aid programme will likely be financed at least in part by the EU budget, according to sources involved in the negotiations.

Market Re-Cap

Stocks traded lower in Europe, with the FTSE-100 underperforming its peers, where a number of blue-chip names were trading ex-dividend, as market participants squared their positions ahead of the key FOMC minutes release later on in the session. In Asia, weaker JPY, which was driven largely by the ongoing outflows from EM, ensured that the selling pressure which emerged overnight following reports that the severity level of the Fukushima leak was raised was somewhat short lived. As a result, the benchmark index settled in minor positive territory and outperformed its peers. On the topic of EM currencies, potential negative feedback loop stemming from any QE tapering by the Fed saw spot INR rate print fresh record high, that’s in spite of the fact that the RBI continues to try and address macroeconomic stability via a series of minor interventions, including tightening controls on domestic capital controls.

In terms of EU related commentary, GR and IT paper underperformed this morning, after Sueddeutsche Zeitung reported that Greece's 3rd aid programme will likely be financed at least in part by the EU budget, while Italy's Berlusconi said to have given Italian PM Letta and his allies ten days to find a solution that will allow him to remain in politics or withdraw from the coalition if Senate votes Berlusconi out of Parliament.

Going forward, market participants will get to digest the release of the weekly DOE report, housing data and of course the FOMC meeting minutes.

Asian Headlines

China shouldn't adjust the benchmark deposit rate and reserve requirement ratio for banks this year, according to a joint report by China Development Bank and NDRC's State Information Centre. State Economist says China potential growth at about 8% according to Xinhua.

EU & UK Headlines

Greece's 3rd aid programme will likely be financed at least in part by the EU budget, according to sources involved in the negotiations.

- According to the report, additional loans would not help as these would further drive up excessively high debt levels and that any new programme would be significantly smaller than the previous two.

- The report further stated that reform conditions will be much less stringent since Greece will have already introduced a significant share of necessary changes.

Italy's Berlusconi said to have given Italian PM Letta and his allies ten days to find a solution that will allow him to remain in politics or withdraw from the coalition if Senate votes Berlusconi out of Parliament.

Germany sells EUR 4.092bln 0.25% Schatz, bid/cover 1.8 (yield 0.23%; retention 18.16%); highest yield since March 2012. The offering by Buba, which also a new line benefited from relative cheapness vs. swaps.

FOMC Minutes due at 1900BST/1300CDT:

- Markets looking for any signs or signals of discussions of tapering ahead of the September FOMC meeting- Minutes unlikely to explicitly signal tapering at the next meeting, but reiterate several on FOMC saw QE tapering likely warranted soon- Expected to once again highlight a discussion between members on the costs and benefits of continued large scale asset purchases

Equities

Stocks traded lower in Europe, with the FTSE-100 underperforming its peers, where a number of blue-chip names were trading ex-dividend, as market participants squared their positions ahead of the key FOMC minutes release later on in the session.

FX

Istanbul skyline reflects cheap dollars now growing scarce. (NY Times)With expectations mounting that the Federal Reserve, led by its departing chairman Ben S. Bernanke, may soon begin to tighten its monetary spigot, Istanbul’s skyline could well be a harbinger of an emerging-market bust brought on by unpaid loans, weakening currencies, and, eventually, the possible failure of developers and banks.

Deutsche Bank said USD/INR could touch 70 in a month or so and it expects a revival by end of the year. Note, INR stabilised overnight following yesterday's RBI actions halting several days of declines in the currency.

Commodities

Crude oil flow through the Iraq-Turkey pipeline to resume on Wednesday night according to a Turkish official.

This morning its was reported that Iraq crude exports via Turkey halted by sabotage.

ES Sider oil port still closed, Zueitina (60-70,000bpd) to reopen soon. The Libyan government have also warned against any illegal shipments leaving the area.

Syria says no truth whatsoever to reports of chemical weapons use near Damascus. This follows reports that a chemical weapons attack killed dozens on the outskirts of Damascus, as claimed by Syrian opposition activists.

Mehr News reported that Iran has produced more than 240 kilograms of enriched uranium to a purity level of 20% since 2010. If this is confirmed in the IAEA’s quarterly report, due around August 27-28, the inventory of 20% gas will rise by less than the output, which has been about 15 kilograms per month.

Scrap gold supply in India could race to at least 300 tonnes - topping flows seen in recent years - two major industry bodies said on Tuesday, as government moves to curb bullion imports lead to a jump in premiums on fast shrinking supplies.

Macro and FX observations from SocGen:

The month of August was well underway to being different and dull compared to the summers of years gone but fear made a sudden come-back into the third week as the epicentre of the recent crisis intensifies over emerging markets. The RBI managed to calm markets down overnight by announcing open market bond buying operation on 23 August, but the FOMC minutes tonight could easily cause EM selling pressure to resume. Will floundering confidence in developing economies chip away at the fragile recovery in the developed economies? EUR/USD has buckled before when things got out of hand in Asia (see chart), so the breakthrough at 1.3400 should not be taken for granted. Not just that, but the ECB will have to make a statement in September for hawkish rate expectations to be toned down. And in any case, there is still Greece where a third aid programme is now under consideration we are told by German finance minister Schaeuble.

All in all, the resilience of lower graded euro periphery debt (Spain and India are both rated BBB- by S&P) is a testimony to (overseas) confidence in the eurozone and the escape route to safety from EM. The scale of capital flows into EM has been enormous in recent years as central bank printing presses went into overdrive in the West and excess liquidity found its way in attractive higher yielding assets. To quote the sage of Omaha, Warren Buffett: it is when the tide moves out (i.e. real US interest rates rise), that you discover who's been swimming naked. India has considerable work to do in restoring investor confidence, and other countries are facing an uphill battle too. After Thailand on Monday, it was Mexico's turn yesterday to report a contraction in Q2 GDP (0.7% qoq). With the Fed not yet having lifted a finger on its asset purchase programme, the emerging market world will be a restless place for weeks to come.

The VIX index has jumped 5ppt to 15.0 since last week and is at levels seen in early July. The 5y average is 24, so risk remains well under-priced. Thus being long volatility makes sense in this environment, particularly in higher yielding and commodity currencies. EUR/CAD and EUR/AUD look set to push on from current levels, in particular the latter after the coded RBA message yesterday. The pace of adjustment will arguably depend on the content of the FOMC minutes tonight and the clues offered with regard to the likelihood of tapering in September. Though the minutes may offer some soothing words for the bond market after acknowledging the weak inflation backdrop at the July meeting, the underlying US labour market trends have continued to strengthen. The path towards higher US yields was interrupted by the emerging market sell-off but the relief may well prove short-lived. The re-pricing of EM assets will continue because the Fed is preparing to buy fewer securities and hence there will be less liquidity to chase higher yielding securities overseas where economic imbalances are coming to the fore.

Prior to the FOMC minutes and US existing homes sales data, Germany will sell 2015 bonds (tap) and the latest UK public finances data will be published. The pick-up in economic growth should make it easier for Treasury Secretary Chancellor to attain his deficit target of £120bn this fiscal year (7.5% of GDP). Treasury coffers are forecast to have returned a £5.0bn surplus in July, traditionally a positive month for the public finances.